SURVIVING MAJOR STOCK MARKET CORRECTIONS: DO’S AND DON’T’S

By MARY LYNNE DAHL, CFP®

August 27, 2015
Thursday PM

Mary Lynn Dahl

(SitNews) Ketchikan, Alaska - As of this date (August 23, 2015), the Dow Jones Industrial Average (DJIA) is down more than 10% from its May 19 high of 18,312.39 and the other US exchanges are in similar basement territory. This is technically referred to as a “market correction” and it means that a lot of portfolios of ordinary people are down as well. Is this cause for alarm? What should a small investor do about it?

You probably already know the answer if you have been reading these Money Matters columns for any length of time. The answer is: add money to your portfolio now, if at all possible, and invest it while we have lower share prices. Do not panic and take your money out of the market. I can say that but I know that a lot of people will, in fact, bail out, certain that the sky is falling. This is such a classic mistake, but people are people and they still fall prey to their emotions. Don’t allow yourself to lose sight of the big picture, the long term view, though. Recognize a major drop in share prices as the bargain buying opportunity that it really is.

Maybe you can’t add money to your portfolio because it is all in a retirement account and you are already retired. You can’t add to it because you no longer have earned income. Well, that’s ok. That illustrates why everyone should have a non-retirement investment account in addition to their regular retirement account. You can always add to a non-retirement investment account, and now is the perfect time to do so. Open one if you don’t already have it set up.

You may be wondering what exactly caused the market to fall over this last week. What was different? Was it the fact that China has devalued their currency? Is it because the US Federal Reserve has indicated it will begin to raise short term interest rates? Is it because Greece is on the verge of bankruptcy? Is it the tragic crisis of migrants fleeing across the Mediterranean Sea to Europe? Is it the wars in the Middle East? Is the US economy unhealthy? What has caused a drop of such magnitude in stock prices in the US?

The answer is that none of these things caused the market drop by themselves. The correction seems to have been triggered by emotion, by investor psychology. Shares prices of many companies have risen to new high, and even with good earnings, the ratio between price and earnings had reached higher than normal levels, so a correction was, in fact, due. The market does not simply go up. It goes up, corrects, goes down, corrects, starts back up, and repeats this cycle over and over again. A correction is exactly what the word implies; a change from an incorrect price to a more correct price. Share prices reflect the ability of a company to earn profits and share those profits as earnings paid out in dividends. Healthy profits produce healthy earnings. Earnings compared to share price is a good measure of what is a fair price for any stock; historical average P/E ratios have been in the range of 14-20. US stocks of many companies had risen in price beyond that ratio, with a ratio of price to earnings being too high. Hence, a correction was due.

Sir John Templeton, one of the great investment gurus of all time, repeatedly said that he was an optimist, for good reasons that he liked to share with the public whenever he got the chance. His outlook during periods of market turmoil and decline was always that things would get better, and it always did. Sir John saw sweet buying opportunities in market crashes. He found security in the US worker and in the companies that produced US goods and services. In 1987, in a speech he made in New York City to the investment world, when the Dow Jones Industrial Average was at about 800, he predicted it would someday top 10,000. Some people laughed out loud. He didn’t care. He knew they were not yet experienced enough to see beyond a year or two, so they could not envision the DJIA going from 800 to 10,000. But he was right, and today it has again moved 65% beyond that number. He would not be surprised, if he was alive, to see it fluctuating between 16,000 and 18,000, or more. He knew that markets grow, go up and down, and reflect the economies of countless businesses worldwide, some of which will fail and some of which will prosper. He was an optimist because he knew that men and women would always go to work, buy groceries and build homes for their families, creating more and more demand for goods and services from companies that provide them. All of these activities create an economy, which in turn goes up and down in cycles, but never totally stops. When an economy slows down, people may spend less on cars, but they still buy coca cola and beer. They may not buy steak, but they still buy chicken and hamburger. When the economy grows and wages rise, people buy cars and homes and refrigerators. They go on nicer vacations. They buy nice clothes. It is a predictable cycle, fueled by the engine of capitalism. It does not stop entirely. The stock market is just part of the economic engine of commerce that finances the entire world’s lives.

The media will make much of a major stock market correction. They have too, because if they don’t, you won’t read their articles and blogs. You won’t listen to them on TV or on your mobile device. You need them to keep you worried, right? It gives the media a reason to exist, so reporting on big moves in the stock market is good for the media. It doesn’t help you make sound financial decisions, though. In fact, it may taint your analysis and prevent you from thinking rationally. Go ahead and listen to the media if you want to, but remember that they are only presenting a very short term picture of what is going on, and only so they can sell advertising and pay their own bills. Remember that and don’t take the media too seriously. Do your homework and make your own financial decisions based on long term data, not short term hype. Don’t wonder where the market will be in 6 days; wonder where it will be in 6 years. See if you can think like Sir John Templeton, who achieved greatness as an investor guru in spite of many short term market experts who said a 10,000 point DJIA would never happen. Boy, were they wrong!